3 Things to Consider Before Investing in Rental Properties

[Editor’s Note: This is a republished post from Passive Income MD (PIMD), a member of The White Coat Investor Network. If you think investing in a rental property is for you, carefully consider these points from PIMD. I would just add one more thing to his first point, make sure you are also maxing out your tax-deferred retirement space before investing in real estate. This is how we invest in real estate. The original post ran here, but if you missed it the first time, it’s new to you! Enjoy!]

If you’ve ever thought about investing for passive income, you’ve probably already considered investing in real estate. Just about anyone currently investing in this asset class will tell you it’s a good idea – and with good reason. Like me, many of you probably know doctors who have been quite successful in this area, and maybe you’re thinking it’s time you hopped on the wagon.

I first caught the real estate bug several years ago, and it has catapulted me toward my ultimate goal of financial freedom. Now that I have some experience, I’m often asked how to start investing. Real estate investments have been greatly beneficial to me, but before I recommend to folks that they should invest, I make sure that they consider the following three points. Before you decide that investing in rental property is for you, carefully consider them for yourself.

1. Make Sure Your Finances Can Handle it

This type of long-term commitment can take its toll on your finances if you’re not well prepared. Investing in a rental property is not a quick in and out situation (unless you’re looking to do a quick flip). For our purposes, it’s best to be thought of as a long-term play.

Make sure all your expenses are well covered, that you have a decent emergency fund, and that the money you’re investing is surplus money you won’t need for awhile. Do you have some expected large spends like college for your children or trying to buy your own home? If so, perhaps this isn’t the time to lock up a large number of funds in an investment.

It’s also critical that you prepare a maintenance fund for both expected and unexpected expenses that come with a rental property. This might include a new roof, water heater, or HVAC system that could end up being a relatively significant cost. Any smart landlord will set aside an amount (~5%) for these capital expenses, also referred to as CapEx.

Again, realize that you can make in the short term by flipping the home, which means you buy and sell in a short period of time. However, for the most part, that’s extremely dependent on the way the housing market is moving. So if you know you need access to these funds in a short period of time, perhaps move on.

2. Decide If You Want to Be a Landlord

Readers of this blog know that I firmly believe that owning real estate is one of the best (if not the best) paths to sustained long-term wealth creation. It can be a great passive income stream. However, it’s not without its headaches. When it comes down to it, being a landlord means dealing with people and all the ups and downs that go along with it.

Don’t want to be surprised with a clogged toilet call on a Saturday night? You can hire a property manager to deal with it, but even so, you still have to oversee your managers and take care of larger issues. If you don’t think you can handle it, consider some less active ways of getting involved in real estate such as investing in crowdfunding, syndication, or a REIT.

Yes, being a landlord can be a pain sometimes, but I believe that the pros of owning real estate directly still outweigh the cons. With a good property manager, small issues will be taken care of and you should only be notified of major issues and larger expenses. Just be sure you know what you’re getting into.

It’s important that you educate yourself on and fully understand all the different methods of making money in real estate and how to plan for different exit strategies. Not sure where to start? I recommend reading The ABCs of Real Estate Investing. After that, I highly recommend paying a visit to BiggerPockets.com.

Is it Worth Investing in Real Estate?

Ultimately, investing in anything is a risk, and real estate is no exception. However, it is my belief that the rewards can far outweigh that risk. Just ask anyone who has a portfolio of cash-flowing properties large enough to cover their expenses. Now that’s passive income and financial independence.

Real estate helped jumpstart my goals of early retirement, and it can do the same for you. Making sure that you’ve considered these issues up front will help make that journey even easier.

Do your research, consider the pros and cons, and finally, start your own path to financial independence, made possible by rental income.

What else do you think needs to be considered before jumping into owning your own properties?

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16 comments

What do you think about buying a condo unit as a rental property? There seemed to be some good condo deals around my area, and their prices are within my reach. With regards to finding a tenant, a family member is already willing to rent if we decide to buy a unit.

I own one condo and it has been an excellent investment. All of the standard real estate precautions apply in terms of finance. I’ve heard others complain value does not rise as quickly, but that has not been my experience. The condo fee is an additional consideration, but trade it for what you get. Mine provides maintenance and security outside the unit, insurance for the common structure, and enforces standards (which help keep up property values). The association replaced the roof on the whole building once at no additional cost to me. However, there is a downside to condo associations. Make sure the bylaws allow renters. And that they will be responsive to you as landlord.

We have two condo rentals. They have been excellent passive investments for us. We have been side hustle landlords for more than a decade. We bought the condos from builders’ floor plans, so new and in very nice downtown and midtown locations. In our city, new condos were either the same price or slightly lower priced than some older condos. We bought at the right time and so we bought our condos at very good prices. One condo is a relatively smaller boutique style type of condo and the other one is a larger high rise one.

There is high demand for rentals in the locations we have chosen. Our condos are surrounded by hospitals, law firms, businesses and subway lines. Some of our best tenants have been a doctor, lawyer, veterinarian, consultant and foreign executives. Our two condos are truly passive for us because of the tenants they attract and also because they are condos as opposed to single homes (at least this is what we have experienced, not saying this is true for everyone).

Perhaps our tenants are so busy working long hours that they really only use the condos for sleeping? We have found that there isn’t much wear and tear in our condos. The excellent location means we can fetch premium rents and the equity appreciation is awesome. We specifically chose to buy condos that don’t have as many public amenities (lower maintenance fees and less things that can break down). Our tenants don’t seem to care about the lack of a swimming pool or hot tubs. Again maybe because they won’t have time to use them anyways?

These two condos of ours are keepers. We carefully took our time to research what and where we want to invest cause our strategy is to buy and hold long term only (less headaches, less transaction fees, greater appreciation over the long run, rental income during retirement). In the future, if we invest in more real estate, we will always stick to only buying condos just because we have experience with these two passive ones that have worked out so well for us.

Another good option is equity sharing. For me, it had most of the advantages and none of the usual landlord headaches. My partners were employees of the hospital where I also worked so I knew they had good well paying jobs. I also got to know them before the deal so I could judge their reliability. I could have done more deals as there were many who just needed down payment money and could afford the monthly carrying costs. I did two, made money, and both sides were very happy.

Good points. Real estate should be a portion of everyone’s portfolio. Always be sure it will make money before you purchase it. Also decide how active you intend to be before purchasing. It’s not good to buy thinking it will be a totally passive investment but not figuring in the cost of a manager. It’s only fully passive if you have someone else be the manager. But you get to decide this issue.

Can anyone speak more about crowdfunding and syndications? As has been said before, real estate is not truly passive and while I understand there’s likely less of a rate of return with investments that invite more middle-men, those also seem to be much less headache as you do not deal directly with any tenants or tenant management.

Compared to actual RE investing, are crowdfunding/syndications that much less in rate of return or even just go with a REIT?

Indeed a good point. I assume it also has a steep learning curve in the beginning as you dip into it in the beginning. Many hours used in the first couple years and then will get easier as you gain experience. Was reading a comment on a prior post where someone said they carefully chose a condo to invest in that was surrounded by high professional businesses (dentists, docs, lawyers, financial firms, etc.) in a nicer neighborhood and their tenants were mostly high earning professionals…which they also mention had less wear and tear and no major issues.

Part of it I feel is also the fun/challenge of the real estate business and having a steady cash flow coming in instead of ‘paper gains’ with more traditional investments…

I think that’s just a mental thing. Money is fungible. The benefit of an investment where a good portion or all of the return is due to appreciation is that you can “declare your own dividend” any time you want, and don’t have to pay taxes on it until you do.

“Ultimately, investing in anything is a risk, and real estate is no exception.”

I have to quibble with this statement a bit. To me, investing in a diversified portfolio of domestic and international stocks and bonds contains a VERY different risk profile than putting your money into a single family home or apartment building. The only reason, in my opinion, that real estate appeals to so many is because of the leverage it allows people to use. I would guess most new real estate investors finance part of the purchase; a lot of posts on BiggerPockets talk about the “cash-on-cash” returns. Downturns can and do happen; the amount of leverage we are exposed to has a significant impact on whether we can remain solvent.

Howard Marks wrote a memo some years ago (“Volatility + Leverage = Dynamite”) that provides a great overview for how to think about leverage; I recommend everyone I know read it.

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